Trend Following Manifesto

Jennfier Bayot of the New York Times writes in her article titled Older Investors Jittery as U.S. Markets Disappoint:

“…Jim Paulsen, chief investment officer at Wells Capital Management in Minneapolis, said he had encountered many investors who were staying on the sidelines because of terrorism fears. “This year still seems to be more about fear than reality,” Mr. Paulsen said. “We’ve had remarkable recovery on many fronts, restoration of profits, re-emergence of jobs, the continuation of low inflation rates and interest rates. But whenever I speak to investors about the economy and the markets, the first question I get is ‘What about a terrorist attack?’ It’s hard to convince people no matter how good the fundamental story is that they should up their equity levels. There’s this ghost out there and no amount of G.D.P. growth can overcome it.”…Karen Orlin, 56, a corporate lawyer in Boca Raton, Fla., said she had already changed her buying habits and retirement plans because of the stock market’s recent fizzle…”I am much more conservative in my expenditures,” Ms. Orlin said. “I’m not as much of a consumer as I was five years ago.”…As far as her investments are concerned, she said she was less concerned with growing her portfolio of mutual funds than she was with simply maintaining its current value, which she declined to give…Mary Pitts, 70, a retiree in Boynton Beach, Fla., who worked for AT&T, had long planned to give her grandchildren the roughly 500 shares she had amassed in various cable and telecommunications concerns over the years. “I just figured I’d put it away and never touch it,” Ms. Pitts said. “I thought my grandkids could have it in 20 years or so.” But even with her long-term outlook, she has found the market’s recent performance unsettling. And so this month, Ms. Pitts sold all of her shares for $6,000, less than a quarter of the $25,000 that they were once worth…”I just held on too long,” Ms. Pitts said. “I had Lucent when it was up at $62 a share. I sold it at $3.”

It’s almost as if the writers out there take glee in reporting about people with bad trading strategies. They seem to enjoy the constant investor implosions, but they never lift a finger to attempt to fix it. The world’s great reporters just keep “reporting” the same ole story. Almost like a Seinfeld episode, their writing is about “nothing”.

“A most interesting book–definitely a ‘must have’ on your shelf. Pull out the plastic and get it!…Trend Following is well constructed, well written and an excellent distillation of the research undertaken by the author. Backed up by trading ‘legends’ like Ed Seykota, it convincingly argues that the most successful trading systems are based on trend following…While you may read the book in bed, especially the first time, it is best read at a desk with a notepad handy. While seeming to come from the perspective of technical analysis it is still a very good book on trading psychology…The book is both a great read and an insightful textbook for all traders and investors.”
Garnett Znidaric
Your Trading Edge Magazine
http://www.yte.com.au
Australia

NY Times writer Danny Hakim presents a great example of the folly of stock tips:

“Jonathan Mirin says he first heard about Wave Systems from a guy named Jerry. “This company’s selling for a dollar a share,” Jerry told him. “In a few years, it’ll be going for 500.” In those days - the late 1990’s - Mr. Mirin was a struggling New York actor in his late 20’s and a teacher in the public schools. The way he tells it, Jerry was a fellow teacher who told him over a cafeteria lunch one day that he had once been a big-time investor: “Limousines, jets, the whole thing.” Yes, he had lost everything in the crash of 1989, but now he was back in the game and had a hot tip to share. “I felt like I had received this tip, and I’d better make the most of it, because I don’t travel in circles where I get tips,” Mr. Mirin said…Mr. Mirin was not alone…Among the faithful was Joe Trippi, who later managed Howard Dean’s presidential campaign…”When it started going up, I figured, well, my theories are confirmed, and my friends would say, ‘You know, Jon, everyone’s a genius in an up boom cycle,’ ” he said. “I thought that for Wave to be doing this, someone must know something…”And then when it started going down, it was stubbornness: ‘I’m not going to admit that I’m wrong.’”…Founded in 1988, Wave has never reported a profit for even a single quarter, and it has lost more than $260 million. During the bubble, profit-free technology companies often won investors’ favor, but they generally could at least boast of substantial revenue. Not Wave. In its latest quarter, it reported revenue of $6,300.”

The Trend Following message is boring. It is not flashy. Trend Followers will never have fun and exciting stories to tell at cocktail parties. But isn’t that the issue: do you want to impress your buddies or do you want to trade for profit like the great traders of the last 30 years?

Brett Steenbarger sent this essay recently:

“Why do we trade? To be sure, trading allows us independence, the opportunity to work for ourselves. Trading also offers the prospects of a lifestyle in which evenings and weekends need not be consumed by work. Some of us crave the competitive aspect of trading, doing fresh battle each day. Others approach trading as a puzzle to be solved, deriving a sense of intellectual achievement. Finally, there is income. A successful trader can make seven figures in a year and many of the traders I work with are living proof of that. So why do they trade? Once you have the money, all of trading’s lifestyle advantages could easily be yours. Needs for competition and intellectual stimulation could be met in so many other ways. Why do traders remain traders long after they’ve won the game? Perhaps we can illuminate this question by asking it of practitioners in other fields. Why do artists continue their craft long after they receive recognition for their paintings, novels, or films? Why do elite Special Forces troops stay in units that test their mettle even after they’ve earned their coveted badges? A gifted athlete such as Michael Jordan earned plenty of money and honors and, in fact, did retire on a couple of occasions only to return to his game. Why? There is something deep here that speaks to the nature of productive work. People retire from jobs and even careers, but they never abandon their callings. For some, work means something more than earning a living or achieving a lifestyle. Work is their path in life. It is the way they have chosen or perhaps that has chosen them for self-expression and self-development. Suppose the pastor of a large, successful church wrote a book, made significant money, and promptly retired from the clergy and all religious life. What would that say? Surely, we would think, this person’s faith could not have been too heartfelt. But why should our productive work mean less to us than the clergy means to a devout pastor? Presumably, the religious life meets deep, important needs for the pastor. Is it really so different for the artist? The athlete? The trader? The great professions are those that serve as personal playing fields. They are the arenas we choose to express and develop ourselves. In mastering a discipline, we cultivate self-mastery. In writing a poem or placing a large trade, we capture in a single act our vision of how we see the world at that moment. The great occupations are great precisely because they are such meaningful playing fields. Long after we’ve earned fame and fortune, the calling remains to be more than we are, to return to the arena and do battle with our limitations. The profound urge to extend the human grasp is common to all the great callings. To run faster, to capture more beauty, to predict ever better: in no small measure, our work is our pursuit of the godlike, however fleeting. Maybe it is our different images of the godlike that animate our career choices. If my deepest view of godhood is that of a meek and all-forgiving Christ, perhaps I will be drawn to an occupation of service. If my deepest view is more akin to the ancient Greeks, whose gods sent heroes on quests, then my calling may be on a battlefield or a playing field. Either way, in work we find something divine within ourselves. Whether as scientists, monks, or traders, we strive for those moments when we are just a little closer to perfection, a little nearer to immortality. That is why we trade.”
Brett Steenbarger

Dan Ferris, Editor of a newsletter titled “Extreme Value”, writes:

“Amazon.com’s initial public offering was 3 million shares at a price of $18 each (presplit). Bill Miller, manager of the Legg Mason Value Trust, bought Amazon’s stock at the IPO, back in May 1997. Miller sold that first position, later saying it was, “the dumbest thing we ever did.” Miller bought Amazon again at $80 a share in 1999. Amazon’s stock price fell apart, just like every other Internet stock. Miller responded by doing the only sensible thing he could do. He bought more. A lot more. As he told Fortune magazine, “We started [buying] again in mid-2000 when the stock was in the $40s, and then we bought it all the way down. Our buying increased as the stock fell. If the stock was $35, we’d buy 50,000 shares; at $25, we’d buy 150,000 shares; and at $14 we’d buy 300,000 to 400,000 shares.” Miller says he finished buying “between $7 and $8.” Miller’s buying strategy goes by a name you might be familiar with, dollar cost averaging. Dollar cost averaging is when you spend the same dollar amount no matter what the stock price is. If you spent $700 for 100 shares last December, that same $700 will buy you about 139 shares at today’s prices. If you bought $10,000 worth back then, $10,000 would buy you 39% more shares today, and so on. Today, Amazon is around $37 a share. Miller’s average cost for the stock is around $19.69 per share. He paid as much as $82 for some of his shares, and he’s still up 88% with the stock 55% below his initial entry price. From his highest price to his lowest price, the stock fell 91%! And he’s still up 88%! I doubt many people can say that they’ve ever made an 88% profit from a stock that fell 91% while they were holding it. Brilliant as Miller’s strategy is… the “trend is your friend” crowd reacts to Bill Miller’s behavior like an ape in front of an obelisk. Buying stocks that are falling in price? Throwing good money after bad? It’s sacrilege!”

How many pure play dot-com survivors were there? 5 or 6 big ones? How many 100’s of companies would you have lost all of your money if you were dollar cost averaging? Trend followers refer to “dollar cost averaging” as “losers average losers”.

Milton Pollack, who was appointed a federal judge by President Lyndon Johnson in 1967 and oversaw many notable corporate corruption cases, has died in Manhattan. He was 97. I used a great quote of his in my book:

“Seeking to lay the blame for the enormous Internet Bubble solely at the feet of a single actor, Merrill Lynch, plaintiffs would have this Court conclude that the federal securities laws were meant to underwrite, subsidize, and encourage their rash speculation in joining a freewheeling casino that lured thousands obsessed with the fantasy of Olympian riches, but which delivered such riches to only a scant handful of lucky winners. Those few lucky winners, who are not before the Court, now hold the monies that the unlucky plaintiffs have lost, fair and square, and they will never return those monies to plaintiffs. Had plaintiffs themselves won the game instead of losing, they would have owed not a single penny of their winnings to those they left to hold the bag (or to defendants).”

Yes, the Judge wasn’t much for whiners.

Linda Stern of Reuters recently wrote in a column titled “Strategies for a Sideways Market”:

“The bulls and the bears are in this together, scratching their heads and wondering what’s going to happen next. Up and down, down and up. As soon as you think you know where the stock market is going, it doesn’t…An increasing amount of money has been flowing into fast-trading (and often short-selling) hedge funds that may be whipsawing the market with their staccato trading patterns…What’s a small-time investor to do? Perhaps it sounds facile, but the best thing to do with a sideways trending market is “not much.” Plain folk who are stashing away money for college, retirement, or that rainy day don’t have the computer models that those hedge fund managers are using. Nor do they have the deep pockets to carry them through should their models fail. But they do have one thing going for them: The upward trend of the U.S. stock market. Most investors who stick with their long-term program of regularly investing in a diversified portfolio will be richer in five years regardless of where the market goes on Tuesday … or Wednesday … or Thursday…The market will shake itself soon enough. And those slow-steady investors will be ready when it does.”

Some commentary on this commentary:

1.) If you actually think you know where the market is headed, you are delusional.

2.) Blaming hedge funds for a sideways market is silly. A sideways market is a sideways market. The concept is not new. There were sideways markets a hundred years ago.

3.) The writer thinks 5 years of buying and holding will solve your problems. Where would you be if you bought the Nasdaq Jan. 1, 2000 and held till today? Would you not be down -60% still? When does the buy and holder of the Nasdaq ever get whole again in this example?

“Trend Following by Michael Covel explains the wisdom behind the trending function of the markets. The practical application of this philosophy is based on the pervasive logic of price behavior. Market Stories and Market theories will come and go but trends will remain. Follow them…and study this book.”

Woody Dorsey
Author of Behavioral Trading and creator of Market Semiotics